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Thursday, July 12, 2007

Who are the behavioral economists and what do they say?

That's the title of a new Tinbergen Institute paper by Floris Heukelom (Universiteit van Amsterdam). She identifies a divide within this economic school between those who see uncertainty as exogenous, and those who consider it endogenous:

The most important financial source for behavioral economics is the Russell Sage Foundation (RSF). The most prominent behavioral economists among the RSF’s twenty-six member Behavioral Economics Roundtable (BER) are Kahneman, Tversky, Thaler, Camerer, Loewenstein, Rabin, and Laibson. The theoretical core of behavioral economics made up of the work of these seven researchers is positioned in opposition to Adam Smith/Hayek type of economics, as exemplified by experimental economists Vernon Smith and Plott; and what is referred to as ‘mainstream’ or ‘traditional’ economics, meaning the neoclassical economics that roughly builds on Samuelson.

On the basis of an overview of the work of these seven behavioral economists, a theoretical division can be observed within behavioral economics. The first branch considers human decision-making to be a problem of exogenous uncertainty, which can be analyzed with decision theory. It employs traditional economics as a normative benchmark and favors a normative-descriptive (prescriptive) distinction for economics. The second branch considers human decision-making to be a problem of strategic interaction, in which the uncertainty is endogenous. Its main tool is game theory. It rejects traditional economics both positively and normatively.

Comments

The problem is with the word "uncertainty". Meaning humans thinks that there is something called "certainty" under human control. That confidence of human mind is a problem. On top of that the so called "behavioral economist" (what a stupid ideal mind invention!)add up exogenous and endogenous terms to uncertainty. Have not they got anything better to do? Do they really get paid for ideally thinking of such foolish stuff? This stupid economists (sorry for calling them stupid) but keep me amazed - what world they are living in? There are NO decision or game theories in human decision making. Ninety five percent of human decision making is just based on its survival - greed, ambition and selfishness. Nothing less and nothing more. Such theories are useless and within 100 years they would be outdated - and forgotten. Please do not feel happy in working on something so useles - that is not going to help a single poor soul of this world.

Traditional economics is based on generalizations, e.g. rational choice, perfect information, value judgments, etc. In the real world, there are many reasons why everyone does not maximize utility, why marginal cost does not always equal marginal revenue, why the optimal combination of guns and butter is not achieved, etc. It seems arrogant to reject orthodox economics only based on anomolies. Nonetheless, behavioral economics has value, although no where near orthodox economics.

Also, I may add, there seems to be a lot of fundamental flaws in behavioral economics. One assumption is there's a disparity between "true preferences" and actual preferences. The example used is Americans want to save more. So, a policy should be designed to induce saving. However, there may not be a disparity between true and actual preferences. Given the choice of spending or saving, Americans prefer to spend. Of course, if interest rates or prices were higher, Americans may save more. Also, experimental economics often don't reflect real economics. Rejecting a $1 gain for another to lose a $9 gain, because of fairness and punishment, may work in experiments. However, in the real world, e.g. in terms of wages and profits or international trade, one side often accepts $1 of the $10 gain (or less than 50%).

Can someone PLEASE enlighten me here. When we do these analyses in Economics its implied that the Agent is represented by a set combination of preferences. These combinations then interact -classically or behaviorally- to produce aggregate effects. And yet this core assumption is totally flawed, isn't it? My preferences change by the hour and depend on so many things - the food i just ate, some surprise i just got about my personal finances (say stocks), even a magazine article i just read!!! (i switched off most lights in my house today after reading about a global warming article today morning). Point is, preferences are variable even WITHIN each agent. So you CANNOT apply some equillibrium principle. The only approach that might come somewhat close to describing the GENERAL effect is some sort of dynamic non-equillibrium approach - and even that will not be able to give any SPECIFIC results - just general conclusions. And if you agree with that, then economics -true, real world, practical economics - can only be understood through computer simulations rather than preference based theories. Am I totally missing the point here?

Any academic who thinks human behaviour, economical or otherwise, follows some mathematically predictable path is smoking pot. Every time economics strays from empiricism into mathematics it goes astray.

AC: Economics ... can only be understood through computer simulations rather than preference based theories

Believe that and your next econometric model is destined for the dust-bin.

When predicting technological evolution, there is no mathematical model on earth that even comes close to a valid forecast. Most is intuitive; the most interesting technique called Delphi tries to drive consensus from expert opinion of forecasts out 5, 10, 15 to fifty years. Beyond that and we are into science fiction.

Economics is the very same. There is empirically observable information regarding and economic phenomenon, but its predictability based upon past data is zilch. Who would have predicted the "dot.com bubble" would start to burst in January 2000, five years before it did. Ten years before?

About a year before, yes. Someone did. A magazine called The Economist. Why? How? It simply sensed that the exaggerated exuberance had gone on too long, and that the law of cyclical gravity would prevail. It did. And, anyone holding technology stocks got swamped.

Look at the economic predictions (also printed by the Economist) in the two years leading up to the bubble bursting. Tell me where you see the nosedive in GDP predicted by any one of the economists that the magazine regularly polls.

I'll put his/her name in for the Nobel Prize in Economic Divination by means of Reading Bird Entrails. Gladly.

Amit, obviously some force, or combination of forces, caused you to save energy. Consequently, another set of forces may cause energy producers to lower energy supply. Disequilibriums take place all the time. However, normally, the greater the disequilibrium, the more powerful forces become to move variables toward equilibrium, one way or another. Also, the sum of individual choices representing the aggregate is not flawed, since it's proven mathematically.

Arthur - you may be right - there exists the land of Narnia and everything is moving towards it. But at any given, observable, real point in the brick-and-mortar world, only disequillibrium exists. And disequillibium by definition is not a predictable point. More so if the informtion overload in today's world causes individual choices and preferences to continuously change - and hence cause ever greater noise in the aggregate. So does it even make sense to talk about the fabled promised land of equillibrium? and don't you think Economics - especially Microeconomics - needs a revision to bring it to street level?

Lafayette - yes, i am actually agreeing with you. My point was that its ironical that the grand theory that claims to be the physics of finance has its only recourse in trial and error simulations. The Economist did predict the bust. But as NN Taleb points out, given enough monkeys and enough keyboards, someone is bound to come up with the Illiad randomly -no disrespect to the magazine. So should Economics come down from its lofty perch, accept the obsoletion it faces and learn some new tricks to be relevant in the new new world?

Amit, economies are dynamic. So, not all vectors will be in equilibrium at the same time. Nonetheless, over time, there is an aggregate equilibrium point, since the sum of all residuals are zero. Economies aren't yet optimized. However, some economies had better aggregate equilibrium points than others, over time, because of better economics.

AC: So should Economics come down from its lofty perch, accept the obsoletion it faces and learn some new tricks to be relevant in the new new world?

That will be difficult for as long as the Nobel Prize is accorded to those who do mathematical economics. And, since the committee that considers the prizes is perhaps made up of recognized mathematical economists, the process seems to feed upon itself.

There is hope nonetheless that the softer sciences (particularly sociology) can one day have their impact upon economic theory, towards advancing the science in a way that is more meaningful to people. (I miss the talents of a JK Galbraith and his manner of explaining economics plainly.)

I would also prefer that the the science becomes more a philosophy, as it started out in the 18th and 19th century. I see examples of Riccardo's theories manifested globally today. I am also keen that the science return to employ utilitarianism towards understanding economic policy.

I cannot imagine that unbridled capitalism is the answer to income fairness around the world, though I am skeptical of returning to the failures of "economic planning" to promote global equitability.

I believe that the "imperialistic" theories of Prof.Gary Becker are more powerful in abstracting human behaviour and social interaction than the theories of the behaviouralists.The age-old neoclassical concepts powerfully explain the structure of our daily life.

I believe that the "imperialistic" theories of Prof.Gary Becker are more powerful in abstracting human behaviour and social interaction than the theories of the behaviouralists.The age-old neoclassical concepts powerfully explain the structure of our daily life.

I believe that the "imperialistic" theories of Prof.Gary Becker are more powerful in abstracting human behaviour and social interaction than the theories of the behaviouralists.The age-old neoclassical concepts powerfully explain the structure of our daily life.

I am curious to read any of reactions to a recent documentary Adam Curtis did for the BBC. Called "The Trap: What Happened to Our Dream of Freedom" if largely criticizes Game Theory as a both limited and limiting point of view of human behaviour. I will post the Wikipedia link which features links to the documentary itself on Google Video. http://en.wikipedia.org/wiki/The_Trap_%28television_documentary_series%29

Game theory seems to work better in the real world than in experiments. For example, I stated above: "Rejecting a $1 gain for another to lose a $9 gain, because of fairness and punishment, may work in experiments. However, in the real world, e.g. in terms of wages and profits or international trade, one side often accepts $1 of the $10 gain (or less than 50%)."

IR:"I am curious to read any of reactions to a recent documentary Adam Curtis did for the BBC. Called "The Trap: What Happened to Our Dream of Freedom""

I'd have to see the documentary but I expect a lot of nonsense from Curtis.
From Wikipedia:"All these theories tended to support the beliefs of what were then fringe economists such as Friedrich von Hayek, whose economic models left no room for altruism, but depended purely on self-interest, leading to the formation of public choice theory. "

This is typically hogwash, and a complete inversion of what Hayek's points were. One only needs to read his Nobel Prize ceremony speech to realise that.
Also, Hayek did economics actively for about 15-20 years of his life, and focused on theory of capital and such, much of his influence came from his political theories, not Economic ones.

This sort of method, twisting an intellectual's argument to make him say the exact opposite of what he meant in order to smear him and prove is point, is not at all new for Curtis' would did the exact same thing with Leo Strauss in "The Power of Nightmares".

Hello.According to behavioral economists, precisely because people are motivated by the fact, "what does the left leg, stock prices are more likely to reflect" the psychology of the investor "than the traditional fundamental indicators. Works of Daniel Kahneman (Daniel Kahneman) influenced many behavioral economists. The multitude of brilliant experiments Kahneman and his colleague, Amos Tversky (Amos Tversky) have shown that people are very inefficient processors of information. They make quick and clumsy solutions rather than based on careful logic. Some of the heuristic assumptions applied to the understanding of markets, based on fitness (the belief that the action or sector will rise in price, because it is easy to remember the past, similar cases) and representative (if the action manifests characteristics that are inherent in the growing stock, it grow).

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